Park the Debt Truck!

by Stubborn Mule on 16 July 2009 · 16 comments

About two months ago, I tried to bring some perspective to concerns about growing government debt in Australia. Last week the opposition has rolled out the “debt truck” to add to the hysteria about growing government debt, so I feel compelled to return to the subject for another attempt.

Last time I looked at net debt data going back to 1970. The data came from a chart in the Treasury paper “A history of public debt in Australia”. The paper also shows a history of gross debt and although I prefer to use net debt, the gross debt data goes back further, all the way to 1911 and so gives a longer historical perspective. As usual, I have posted the data on Swivel.

The alarmists like to trade in dollar figures, pointing to forecasts that gross government debt will peak in 2014 at $315 billion, which will be an all-time record. Of course, that ignores the effects of inflation, so it makes far more sense to look at the debt as a percentage of gross domestic product (GDP). Expressed this way, the 2014 forecast amounts to an expected 21% of GDP (while net debt will be 14%).  As is evident in the charts below, this is about the same as in the years following the recession of the early 1990s and it is nowhere near levels in the more distant past. Immediately after World War II, gross debt reached an enormous 125% of GDP.

History of Government Debt

Figure 1 – Australian Government Debt (1911-2008)

If you are wondering about the shaded bands in these charts, they indicate periods of Labor Governments. The opposition is fond of saying that debt falls under Coalition governments and rises under Labor governments. Looking at the data, it is certainly true that government debt fell through both the Menzies and the Howard years (a pairing that would, I am sure, warm the cockles of our previous prime minister’s heart). Beyond that, the link is not so clear cut. What seems more apparent is that government debt fell during good economic times and rose during bad economic times and, moreover, the Coalition have not had a monopoly on good economic times nor Labor on bad. This pattern should not be the least bit surprising. When the economy booms, tax receipts rise and unemployment falls, reducing the cost of welfare payments and when it falters, the opposite occurs. As a result, the government tends to run fiscal surpluses in the good times, paying down their debt, and deficits in the bad times, increasing debt once more.

Recent History of Government DebtFigure 2 – Australian Government Debt (1960-2008)

What the debt demonisers fail to realise is that this counter-cyclical pattern of government spending is a good thing. The increase in welfare spending in troubled economic times helps boost economic activity, softening the impact of a slowdown, which is why welfare spending is often referred to as an “automatic stabiliser”. In more extreme downturns, such as the one we currently face, the government can supplement the automatic stabilisers with additional stimulus spending.

More importantly, government debt is very different from personal or business debt and is not something to be afraid of. In Australia, we have a currency that is not tied to other currencies, nor to gold or any other commodities. It is “fiat money”, effectively under the control of the government. Furthermore, all of the government’s debt is denominated in Australian dollars. This means that the government can, in fact, never run out of money, unlike individuals or businesses. So, any comparison between government debt and household debt is meaningless. Of course, in practice, governments should control their spending. If they kept increasing spending when the economy was strengthening, there would come a point where this spending would become inflationary. But this is a very different kind of constraint than I face on my spending! To dig deeper into the implications of fiat currency, monetary theory Bill Mitchell has a lot of material on the subject on his blog. A good place to start is his post on gold standard myths.

So, there is no substance to the fear that the opposition is trying to excite with their debt truck. Government debt is not what we should be worrying about. What is more concerning is private debt. Since individuals cannot issue new currency to repay their loans, excessive household debt can be a real concern. And, the chart below shows that there is something to be worried about. While the Coalition may be very proud of the record of government debt reduction during the Howard years, they should not be so happy about what happened to household debt under their watch (and you thought I was being easy on Howard before!). Instead of focusing on the possibility that government debt may reach 14% of GDP by 2014, perhaps the opposition’s debt truck should drive around the country alerting everyone to the fact that household debt is already over 100% of GDP.

Govt and Household Debt

Figure 3 – Household and Government Debt (1976-2008)

Of course, there are some commentators, such as Steve Keen, who are rightly concerned about the excessive levels of household debt. It is very likely that Australia and many other developed countries around the world will experience an extended period of private sector “deleveraging” (debt reduction). As long as consumers are saving rather than spending, this will translate to far lower economic growth than we have been used to in recent years.

To this point, I agree with Keen. Where I disagree is the extent to which this deleveraging will result in massive declines in Australian property prices. But that is a topic for another post, the long awaited sequel to my recent post on property prices.

UPDATE: for a Nobel Prize-winning perspective, here is Paul Krugman arguing that government deficits saved the world.

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{ 9 comments… read them below or add one }

1 Danny Yee July 16, 2009 at 11:01 pm

I think it’s gone beyond “very likely” that all developed countries will experience significant deleveraging. Even in Australia, corporate deleveraging is progressing rapidly. The outright failures of companies such as Babcock&Brown, Allco Finance Group, Timbercorp, Great Southern, Storm Financial, etc. are the extreme examples. Then there are the massive equity raisings by the banks, property trusts, and other companies trying to reduce debt levels. And infrastructure and property trusts are trying to sell assets.

Commercial property is in big trouble. All that’s left standing is Australian (and maybe some Canadian) residential property. (And even there, it’s worth taking a glance at Mosman or the Sunshine Coast.) And I just don’t see how that can persist. Given how much of Australian debt is housing debt, I think the latter has to contract significantly – and as that happens, houses prices have to fall.

How far houses prices will fall I don’t know. But I think it’s going to be enough to put some of our smaller banks under serious pressure.

2 APJ July 17, 2009 at 12:30 pm

The Libs like the shock and awe debt truck tactic because it caters to the muppets out there who, unfortunately, believe every headilne they ever see. They’ll believe “debt truck” with the same vigour they absorb the “Human bat child found in cave” – type of stories. You can call the average Aussie many things, but one of them is not a rigorous scrutineer of the facts. Costello was tremendous at this, because he is a great understander of base instincts, and taps into the vein of the average ounter whoe 2nd job it seems is to be professionally outraged at just about anything. Never a man for the big picture, or a great thinker about how the financial system actually works, he would latch onto “Labor’s debt” repeatedly when trying to nuke the government bond market. Thank God he didn’t succeed given recent developments, and the strategy of buying bonds at intergenerational lows in yield (2003) and selling equity that had tanked (Telstra) was never that bright an idea. In squandering a terms of trade-induced budget surplus bonanza on tax cuts and not infrastructure (and dragging in the “politically captured” jackoffs in State politics), he has consigned finances to a much poorer state in the longer term, and contributed to the personal debt problem you note above. As a Treasuer, he was the SIV of the political sphere – an approach that works in good times, but which fuels imbalances and gets reamed when things turn down. If only we could ave a Treasuer interested in what the portfolio should deliver – stabiliy – and not uninformed pettiness. Unfortunately, we still don’t have one….

3 stubbornmule July 17, 2009 at 1:11 pm

APJ: you’re not wrong about the lack of understanding out there! It reminds me of a piece in the AFR last year about Costello’s lack of understanding of RBA market operations. For those without a subscription, here is a snapshot of the article.

4 had enough July 17, 2009 at 5:31 pm

you say, dont be afraid of government debt. government can never run out of money, simply just print more.thats FANTASTIC.,we should all give up slaving for the goverment,..banks ,..and all the other parasites,and let the m look after us for a change. geeeeee im stupid

5 stubbornmule July 17, 2009 at 5:38 pm

@had enough: I may be happy for the Government to attempt to boost a flagging economy, but that doesn’t mean I’m ready to throw myself on the bosom of Kevin for all my wants and needs.

6 stubbornmule July 18, 2009 at 4:57 pm

I have added a link to a Paul Krugman opinion piece where he argues that government deficits saved the world.

7 Paddy July 20, 2009 at 10:14 am

The long time-series is great for persective. But there are two other things that would also aid understanding. First, what is out debt (net national/private/public) in relation to comparable nations, and second, what level should debt be? The former is well within the mules paddock – data hound that you are. The second is a terribly hard question, but your thoughts would be welcome.

8 stubbornmule July 20, 2009 at 11:31 am

Paddy: this earlier post has some international comparisons of Government debt, but I agree that some comparisons of private debt would be enlightening too. As for the “right level” of debt, that is a harder question as you say. I’d see Government debt as simply an outcome of the economic cycle, so there is no right level. Governments can spend too much in a given period if they go over and above levels to compensate for inadequate private sector demand, but if the economy stays weaker for longer, debt will rise further, but it will eventually fall again once conditions improve. As for private debt, there must be an upper bound (unlike Governments there is a hard income constraint). It’s hard to say what the right level is, but I’d say it has gone too far of late.

9 Jobs business August 8, 2009 at 11:15 pm

The graphs of the debt look interesting. The government debt has come down and the household income has gone up. But how about the GDP ratio vs per capita income. Has that also gone up.

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